Chapter 15
Uncollectible Accounts
1
College Accounting
10th Edition
McQuaig
McQuaig
Bille
Bille
Nobles
PowerPoint presented by Douglas Cloud
Professor Emeritus of Accounting, Pepperdine University
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© 2011 Cengage Learning
Two Methods of Accounting for
Uncollectible Accounts
 The allowance method is consistent with the
matching principle, in that it enables firms to
match sales of one period with bad debt
losses of the same period.
 The specific charge-off method traditionally
has been used by small businesses. It is the
only method approved for federal income tax
purposes.
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The Credit Department
 The Credit Department evaluates the debtpaying ability of prospective customers and
determines the maximum amount of credit to
extend to each customer.
 Credit managers oversee the firm’s issuance
of credit, establish credit-rating criteria,
determine credit ceilings, and monitor the
collections of past-due accounts.
 A credit manager must have a bachelor’s
degree in finance, accounting, economics, or
business administration as a minimum.
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The Allowance Method of
Accounting for Bad Debts
 Most big firms use the allowance method
of accounting for bad debt losses for
financial reporting, which is consistent with
generally accepted accounting practices
(GAAP).
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The Allowance Method of
Accounting for Bad Debts
 The general journal and T account form show the
adjusting entry for the estimated bad debt losses
for Huan Company.
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The Allowance Method of
Accounting for Bad Debts
 The purpose of the adjusting entry is to
increase Bad Debts Expense by the
amount of the estimated loss and to
produce a collectible figure for the book
value of Accounts Receivable.
 Allowance for Doubtful Accounts is
classified as a deduction from Accounts
Receivable; it is a contra account.
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Bad Debts Expense and Allowance for
Doubtful Accounts on Financial Statements
 Bad Debts Expense appears on the
income statement as an operating expense.
 If a firm subdivides operating expenses into
selling expenses and general expenses,
then they list Bad Debts Expense as a
general expense.
 Allowance for Doubtful Accounts is listed
immediately below Accounts Receivable
in the Current Assets section of the balance
sheet.
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The Allowance Method of
Accounting for Bad Debts
Three ways can be used to estimate the
amount of bad debts expense:
1. Based on the aging of Accounts
Receivable
2. Based on a percentage of Accounts
Receivable
3. Based on a percentage of net sales or net
credit sales
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Adjusting Entry Based on Aging
Accounts Receivable
 The most common technique for estimating the
total uncollectible amount of Accounts
Receivable is based on aging of Accounts
Receivable.
 When a company uses the aging method, each
charge customer’s account “is aged” by:
1) determining the age, in numbers of days, of each
account and
2) determining the number of days the account is past
due.
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Aging Accounts Receivable
Adjusting Entry Based on Aging
Accounts Receivable
The adjusting entry is made large enough to make
the balance of Allowance for Doubtful Accounts
the same as the estimated uncollectible accounts.
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Adjusting Entry Based on Aging
Accounts Receivable
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Adjusting Entry Based on
Estimating Bad Debts as a
Percentage of Accounts Receivable
Raymond Company’s adjustments for
uncollectible accounts:
The firm’s average loss over three consecutive
years is: $4,640/$151,000 = .03 = 3%.
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Adjusting Entry Based on
Estimating Bad Debts as a
Percentage of Accounts Receivable
 At the end of 2013, the balance of Accounts
Receivable is $60,100 and the credit balance
of Allowance for Doubtful Accounts is $285.
 The company estimates the uncollectibles to
be $1,803 ($60,100 x .03).
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Adjusting Entry Based on
Estimating Bad Debts as a
Percentage of Accounts Receivable
When the figure for the adjustment is based on a
percentage of Accounts Receivable, you make an
adjusting entry to bring the Allowance for Doubtful
Accounts balance up to the desire number ($1,803 –
$285 = $1,518).
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Adjusting Entry Based on
Estimating Bad Debts as a
Percentage of Accounts Receivable
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Adjusting Entry Based on Estimating
Bad Debts as a Percentage of Net
Sales or Net Credit Sales
Estimate Based on Net Sales
Net Sales
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Adjusting Entry Based on Estimating
Bad Debts as a Percentage of Net
Sales or Net Credit Sales
Estimate Based on Net Sales
One percent of net sales is $6,815 ($681,500 x
.01), so the firm uses this amount directly for the
adjusting entry.
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Adjusting Entry Based on Estimating
Bad Debts as a Percentage of Net
Sales or Net Credit Sales
Estimate Based on Net Credit Sales
Credit (charge) sales
Less: Sales Returns and Allowances
Sales Discounts
Net credit sales
$736,000
$25,200
5,200
30,400
$705,600
$705,600 x .0075 = $5,292
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Adjusting Entry Based on Estimating
Bad Debts as a Percentage of Net
Sales or Net Credit Sales
Estimate Based on Net Credit Sales
Note: The present balance of Allowance for Doubtful
Accounts is not involved in determining the amount of
the adjusting entry.
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Accounts Receivable Turnover
Accounts receivable turnover is the number of
times charge accounts are turned over (paid off)
during a given year.
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Accounts Receivable Turnover
Assume the following information for 2011 and
2010 for Southern Office Furniture.
2011
Net sales on account (from the sales
journal)
Beginning accounts receivable
(from Accounts Receivable account)
Ending accounts receivable (from
Accounts Receivable account)
2010
$330,000 $302,000
39,680
37,500
45,840
39,680
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Accounts Receivable Turnover
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Closing the Bad Debts
Expense Account
Before Closing
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Closing the Bad Debts
Expense Account
After Closing
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Entry to Write Off a Charge
Account in Full
Write Off Entry in the General Journal
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Entry to Write Off a Charge
Account in Full
Write Off Entry in the T Accounts
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Entry to Write Off a Charge
Account in Full
Accounts Receivable Ledger Account
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Entry to Write Off a Charge
Account in Full
Net Realizable Value
Note that the book value does not
change because of the write-off.
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Entry to Write Off a Charge
Account Paid in Part
On April 21, Paschal Company received 10
cents on the dollar (10 percent) in settlement of
a $683 account owed by its customer, R. L.
Renk, a bankrupt customer.
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Compound Entry to Write Off a
Number of Accounts as Uncollectible
On December 31, Olney Company writes off
several accounts as uncollectible.
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Collection of Accounts
Previously Written Off
Parsons Company sells merchandise on account
to P. Nichols for $585 on May 5, 2010.
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Collection of Accounts
Previously Written Off
Parsons Company makes unsuccessful attempts
to collect the Nichols debt, and the statute of
limitations finally expires. Parsons cannot
collect even by going to court, so the account is
written off as a bad debt.
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Collection of Accounts
Previously Written Off
But on Septembers 15, 2013, P. Nichols suddenly pays
her account in full. Two entries are required, the first to
reverse the write-off entry (which reinstates the account).
The second records the collection.
Collection of Accounts
Previously Written Off
What if P. Nichols had gone into bankruptcy and settled
her account with Parsons Company by paying it 5 cents
on the dollar?
The following entry recognizes the bankruptcy settlement.
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Collection of Accounts
Previously Written Off
The second entry records the collection of cash.
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Specific Charge-Off
of Bad Debts
 The specific charge-off method of accounting for
bad debt losses is a simpler system for writing off
charge accounts determined to be uncollectible.
 On April 16, 2010, Roly Company sold merchandise on
account to H. R. Mitchell for $182.10.
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Specific Charge-Off
of Bad Debts
Mitchell never paid his bill. Finally, three years
later, on September 1, the accounting writes off
the Mitchell account.
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Specific Charge-Off
of Bad Debts
 This method is easy to use but can cause
inaccurate matching of revenue and expense.
 This method is used for tax purposes by most
businesses, even though they may use the
allowance method for financial reporting.
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Reinstating Previously Written Off
Accounts—Specific Charge-Off Method
On May 2, 2014, H. R. Mitchell returns and pays his
$182.10 bill.
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Federal Income Tax Requirement
For each account charged off a separate record
should be maintained for reporting bad debt
losses. This record must contain the following:
1. A description of the debt, including the
amount, and the date it became due
2. The name of the debtor
3. The efforts that have been made to collect
the debt
4. Why it has been decided that the debt is
worthless
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